Thoughts on Angel Investing: Angel Bootcamp

Yesterday, I was fortunate and lucky enough to attended Angel Bootcamp, an invite-only event put on by Jon Pierce that featured talks from prominent angels from both inside and out of Boston.

I came in expecting some tremendous insights that would help me find, pick, and choose potential investments. I walked out thinking to myself, “nope, this is a dumb game to play with my money.”

Instead of mature discussions on how angel investing can fit into a well-rounded investment portfolio and the sorts of risks associated with it (correlations to the tech industry, potential overlap with public securities, liquidity, tax implications, equity versus debt investments, angel investing as an uncorrelated alpha add to cheap beta investments, et cetera) — I just heard a lot of “hobby” discussion.

Let me break down some thoughts:

As a single angel investor, let’s assume I have $100,000 I want to invest, per year, for the next 5 years. I am looking for anywhere between 4-10 deals a year (so $10-$25k). This isn’t a tremendous amount of money in terms of private investing, so most likely I am limited to the seed round. This puts me directly infront of the riskiest investments — but also those with the greatest potential return. Except for one problem: I don’t necessarily have the capital to retain my pro rata investment in series A, so I might just get diluted out of my great return. Lots of risk and a potentially capped return? Sounds like a great investment to me!

Ignoring that, I first need to go find some investments. This in-and-of itself is difficult. There was a lot of discussion about how AngelList is changing the game and making deal-flow less of an issue, but the general consensus was that there is no substitute for developing your own private network. So, realistically, I now need to start attending tech shows around the country to increase my potential of seeing good deals.

So let’s say I have put in the time and effort to go to some shows and I start finding some potential seed deals. Well, now I am at direct odds with the entrepreneurs. As someone who has worked very hard for their money, I want to make sure it is well taken care of and in good hands. Seed stage entrepreneurs just want you to write a check and get the fuck out of their way. Fortunately for them, the angel investing game is becoming competitive enough that they can start demanding it: because if you don’t write the check on a good deal, most likely someone else will and tough luck for you. The advice of the day for new angels seemed to be “just write checks.” How this is good advice, I will never know.

The big problem is that angel investing isn’t like investing in public securities. With public securities, everyone has the same investment choices (more or less), and your decisions are really limited to asset allocation and specific security selection. Not true with angel investing. Me being part of a deal necessarily means that someone else isn’t — which means that deal access and choice is a tremendous edge. It isn’t as if Coca-Cola stock is only available in a few select mutual funds. In fact, it is just the opposite: almost every large-cap mutual fund holds Coca-Cola. The exact opposite is true in private markets — so being part of any one deal can be a huge portfolio changer. On top of that, unlike public markets, I can’t immediately get tremendous diversification effects from just buying an index or basket (cheap beta). In the private markets, I have to enter into a whole lot of deals before I start seeing portfolio diversification effects — and even then, they are all tech plays!

Ultimately, however, you are going to be limited in the deals you have access to. More than likely, as a new angel, if you are seeing a deal that isn’t from your own personal network, it’s probably because someone else looked at it and didn’t take it. You’re probably scraping from the bottom of the barrel, which will necessarily skew your potential returns.

So as a new angel, we have a bunch of issues:

1. Capital constraints limit the rounds we can seed in.

2. Angel investing is becoming competitive enough that entrepreneurs can start making demands which limit our ability to perform due diligence on the investments

3. Access to deals is an extremely limiting factor in our performance, and almost necessarily the reason why new angels should expect to underperform established angels

So what is a new angel to do? Well, you can decide to do this full time, chalk up your first couple investments as the cost to play the game and start to build a network and reputation. If you take that route, you will probably end up doing alright in the long run (so long as you have good capital preservation).

Let’s examine the genius of the TechStar, YCombinator, and 500Startups funds. They have built such a brand that seed stage companies actually COMPETE to be in their portfolios. Why? These funds offer tremendous benefits for the businesses in feedback, funding access, distribution, mentoring, and a whole slew of other opportunities. So these funds will get to pick the cream of the crop — and the rest of us are left with what is left over. On top of that, the funds also get the opportunity to help shape the companies through mentoring — which is exactly what entrepreneurs are saying they DON’T want from private angels in the seed stage. Finally, these funds have enough capital to do selective follow on rounds, so they can double-down on their good investments and increase the performance of their portfolios.

So, to recap the issues of a private angel: 1) Access to (good) deals is most likely poor unless you make it a full-time gig, 2) You have little to no influence on the business, 3) Lack of capital can lead to poor performance, and 4) small portfolio size means no diversification effects. Incubators and accelerators, on the other hand, have successfully solved all these issues. Their brands give them access to the best deals, they get tremendous influence on the business, they have funding to do follow on rounds, and they take anywhere from 20-150 startups a year into their portfolios.

These problems are why I think I heard a huge lack of investment maturity at the conference yesterday. The fact of the matter is: this really isn’t a game you are very likely to win. Which, in my opinion, is exactly why you heard a lot of angels saying, “assume you will never see your money back,” and making excuses about the side benefits of their investments (“helping create jobs in America,” “helping the tech ecosystem”). At the end of the day, you really just can’t compete.

So if it is a hobby? Great. There are definitely more expensive ones out there, and getting involved in angel investing seems like it can be a lot of fun. But as a potential investment? You’re probably better off talking to your financial advisor and finding a seed-stage firm you can become a limited partner of. It’s what I plan on doing.

I’ll leave you with a general critique of the conference, and most conferences in general: Advice is great, but qualified advice is better. Just because you blog a lot about investing doesn’t mean you know what you are talking about. When I meet with clients, I am expected to show them my track record. If you are going to give advice, please at least be transparent about your own track record. I recognize that this was a free conference and speakers were not paid, but misinformation is dangerous.

TL; DR: Angel investing is probably a dumb investment when you really look at it. Most likely, you’re better off allocating a portion of your investment portfolio into a seed-stage venture firm.
For more info please visit: http://coreyhoffstein.com/2011/06/15/thoughts-on-angel-investing-angel-bootcamp-2011/

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